A 28 year old engineer walked into my office the other day with a question about his personal finances. Joe (not his real name) was the owner of a 2002 Mustang GT which he had finally paid off after five long years of payments. I had helped Joe with his taxes a few weeks ago. I had saved him a few bucks and more importantly earned his trust. He really wanted to trade in his Mustang on a new one, but wanted my financial opinion on the matter first. My gut reaction was that it was much more expensive to drive a new car than a used car. Being an engineer Joe did not want a "gut" reactions instead he wanted facts.
I decided that it would be a fun exercise to run the numbers and find the true cost of the car both for the term of the loan and the long term effect at retirement. We began by defining some variables.
The cost of the new GT 2dr Convertible (4.6L 8cyl) Mustang according to http://WWW.Edmunds.com is $ 31,268 which is a bit expensive, but the engineer is making good money and loves Mustangs. The trade in value of the existing 2002 GT Mustang is $ 7,300 according to Kelley Blue Book. The young man has decent credit and was able to obtain a 9.5% finance rate on the prospective new car purchase. Joe had the choice of buying the new car and trading in his old one or keeping the old car and investing the cost difference. The difference he wanted to invest in his favorite mutual fund Fidelity Value Fund (FDVLX) which has a ten year track record return of 12.64%.
He figures that it will cost an extra $ 80 a month to pay to set as for the increased repair cost of the used vs.. the new car. One final variable is the full coverage insurance which will be $ 290 for full coverage as compared to $ 90 a month for liability only. The value of the $ 623.37 difference invested in the Fidelity Mutual fund with a rate of return of 12.64% after five years will be $ 51,778.72. Now at this point Joe would have a ten year old Mustang worth $ 4,900 and mutual fund worth $ 51,778.72 for a net value of $ 56,678.72 while if he would have purchased the new car it would have worth around $ 8,000 with no mutual fund.
Joe was stunning he had a choice of being 33 years old in five years with a mutual fund + a 2002 car worth 56,678.72 or just a 2007 car worth $ 8,000. I asked him if it was worth $ 48,678.72 dollars in five years to own a new Mustang rather than driving his old one. The answer was obvious he would keep the his Mustang. Here is the real shocker if he just kept the $ 51,778.72 in the mutual fund and did not add another dime between 33 and retirement age of 65 he would have $ 2,885,514 more than enough to retire on. When I think of these numbers the new car smell does not smell as sweet.